You may have heard people talking about your Balance Sheet or Profit and Loss Account (or P&L) but have not been sure exactly what these terms mean or what information they provide? If that is the case then hopefully this article will explain both and show how they are important, and useful, tools that show how your business is performing.
The Balance Sheet
The Balance Sheet gives a snapshot of how much the business is worth at a particular date in time. While the Balance Sheet is generally run at a business’s year-end, it can also be run at any point during the year.
The first part of the Balance Sheet shows the business’s assets. These are split into Fixed Assets, which are the value of expensive items such as property, computer equipment, machinery, furniture and other high value items, and Current Assets, such as cash at bank, money owed by customers, etc.
The Balance Sheet then shows the liabilities of the business. As with the Assets the Liabilities are split into two groups which are Current Liabilities and Long-Term Liabilities. Current Liabilities is money due within one year, such as short-term loans, outstanding bills, etc, and long-term liabilities would include things such as mortgages or loans that are not due to be repaid until one year or more.
The difference between the Total Assets and the Total Liabilities gives an indication of the value of the business at that particular moment in time.
The next section on the Balance Sheet is the Capital and Reserves. Apart from the amount subscribed for any shares in the business it consists of the total from the Profit and Loss Account, or Retained Earnings. The total of these give the Shareholders Funds (sometimes called Owners Capital or Equity). This total will equal the difference between the Total Assets and the Total Liabilities calculated above and these totals are called the Balance Sheet Total. If the total of the Shareholders Funds does not equal the difference between the Total Assets and the Total Liabilities then something has been miscalculated somewhere on the Balance Sheet and you will need to investigate the difference!
If the Balance Sheet shows a positive figure then the business could be said to be healthy but if the Balance Sheet shows a negative figure then this may be a bad sign as the business may not have enough money available to pay off its debts. You should also check the Current Assets exceed the Current Liabilities to ensure your business is still solvent as trading whilst insolvent is illegal.
Example Balance Sheet for a small Limited Company:
The Profit and Loss Account
Often shortened to P&L, this shows the business’s income and expenses over a given period of time. As with the Balance Sheet, this is normally run at a business’s year-end but can also be run at any point during the year and can be for any period of time. A number of business owners like to see a monthly Profit and Loss Account so that they can keep track of income and expenses on a monthly basis to ensure there are no shocks at the end of the year!
The business income from sales or services supplied is called Turnover and expenses are split into Direct Costs, or Cost of Sales, which are the expenses linked directly to the business’s sales and Overheads which are general expenses of the business. For example the cost of buying material or stock would be Cost of Sales and office rent, utility bills, salaries, stationery, etc, would be Overheads.
Turnover is listed first on the Profit and Loss Account and underneath that the Cost of Sales are listed. The difference between these figures is the Gross Profit. Underneath this figure is listed the Overheads, often split into the various different categories, and the total of the Overheads is subtracted from the Gross Profit to give the Net Profit.
The Net Profit is added to the Balance Sheet to form part of the calculation to give the Shareholders Funds. You can also work out your business’s gross profit margin by dividing the Gross Profit by the Turnover and the net profit margin by dividing the Net Profit by the Turnover. These calculations are useful for comparing how the business has performed from one period to the next and can warn a business owner if their costs have been creeping up or sales have been dropping off.
Example Profit & Loss Account for a small Limited Company:
